When you embark on the process of selling your business you may feel a bit like Alice in Wonderland. Suddenly you’ve entered a place where short feels long, small sounds large, and there’s a riddle to be answered around every corner.
The business-for-sale environment can indeed give you the feeling that either things have gotten a lot bigger, or you and your business have somehow shrunk.
In this post we’ll shed some light on the concept of size when it comes to selling your business. In particular, we’ll look at:
- How business brokers view the size of a business, and
- Why the size of a business matters to a business broker.
Let’s not waste any time and jump straight down the rabbit hole.
How business brokers view the size of a business: Sales
Business brokers judge the size of a business by two metrics that are found on the Profit & Loss Statement: Sales and pre-tax Earnings.
The M&A world in general, which includes business brokers, sorts businesses by Sales into the following buckets:
- Main Street (Annual Sales < $5M)
- Lower Middle Market (Annual Sales $5M to $50M)
- Middle Market (Annual Sales $50M to $500M)
- Upper Middle Market (Annual Sales $500M+)
You will certainly find variations in how these four main categories are defined. Some say Main Street applies to businesses with less than $2M in sales, or even less than $1M in sales. Others say the Lower Middle Market tops out closer to $25M not $50M. Regardless, business brokers and M&A advisors use sales as a way to define which “sandbox” they play in.
For more on the difference between business brokers and M&A advisors, check out our Ebook Business Broker or M&A Advisor: How To Find The Right Pro To Help You Sell Your Business.
How business brokers view the size of a business: Earnings
Annual Sales is a pretty straightforward number to get at. But what does Earnings mean, and why would a business broker care?
Pre-tax Earnings can refer to a number of financial metrics, including:
- EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization
- EBITDA (Adjusted)
- EBIT (Adjusted or unadjusted)
- SDE – Seller’s Discretionary Earnings
- SDCF – Seller’s Discretionary Cash Flow
The most appropriate pre-tax Earnings metric for your business is determined by the potential buyer for your business. If the likely buyer is an individual wanting to leave their job and become the owner-operator of your business, they will focus on Seller’s Discretionary Earnings. If the likely buyer is a private equity group, they will be more interested in adjusted or unadjusted EBITDA. If your business is anticipating future capital expenditures, buyers may be more concerned with EBIT.
Remember that businesses are valued based on a multiple of Earnings. Therefore, nailing down the right pre-tax Earnings metric for your business is critical because it gives the business broker a sense of what your business may be worth to buyers.
Why the size of a business matters to business brokers
The reason a business broker or M&A advisor wants to get a clear sense of the size of your business — based on Sales and Earnings — is because they want to understand what it may be worth to a buyer. And if they know what your business is worth, then they’ll also have an idea of what they’ll get paid.
The majority of a business broker’s compensation comes from their commission or “success fee” on the sale price of the business. Most seasoned business brokers develop a size range for the businesses they work with that correlates with the size commission they prefer to make on a sale.
To clarify a bit further, I’ll use myself and Allan Taylor & Co. as an example.
We say on our website that Allan Taylor & Co. works with client businesses that have between $500K and $5M in pre-tax Earnings. Let’s be conservative and assume that Main Street and Lower Middle Market businesses sell for an average multiple between 3 and 5 times Earnings (again, this is a conservative multiple range). That means Allan Taylor & Co. typically works with businesses that sell for between $1.5M on the low end and $25M on the high end. Not surprisingly, most of the businesses we work with fall somewhere in between that range, and there are more that fall towards the lower end than the high.
You can take this a step further and deduce that my firm’s target commission or “success fee” is at least $100K. [Apply the Double Lehman scale — see FAQ’s at the bottom of this page — to the low end of the selling price of the businesses we work with and you come up with $140K.]
Even Main Street business brokers who work with small, mom-and-pop (“micro”) businesses usually have a minimum commission, often in the $10K to $25K range. Knowing that the average commission is 10% for business brokers, a minimum commission of $25K is likely to mean that the business broker works with businesses that sell for at least $250K.
The point here is that most business brokers and M&A advisors have a cut-off point in terms of their commission; an amount below which they typically won’t go. (While your business may be too small for them to sell, many M&A advisors are happy to work with you on increasing the value of your business.)
At the end of the day, the answer to the question of whether your business is too small for a business broker is this: It depends on the business broker. What looks too small to one broker may be just right for another. Plan on interviewing at least a handful of business brokers to find the right fit for you and your business.
Do you have questions about selling your business? We’re ready to get the conversation started when you are.
You can learn more about this topic in our Ebook Business Broker or M&A Advisor: How To Find The Right Pro To Help You Sell Your Business.